EXIT

Tackling SaaS ChurnWhite Paper

Table of content

01 Executive Summary

02 Introduction

03 The cost of Churn

05 Best practices in Churn prevention

06 Conclusion

07 About PayPro Global

04 Causes of ChurnA hidden trapIdentifying the root causes

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As Cloud Computing is gradually transforming

the core nature of the software business model,

the software-as-a-service (SaaS) companies

require new metrics to measure their success.

Indicators such as customer lifetime value (CLV),

monthly recurring revenue (MRR), and the

customer acquisition cost (CAC) ratios are rapidly

becoming well known and frequently used

metrics.

However, it’s the less prominent levers that often

separate the market leaders from followers. In a

recurring revenue business, understanding where

to pick up an extra half percentage point each

month can lead to double digit gains in

annualized revenue. Missing these indicators, on

the other hand, can negatively affect a company’s

growth on the long run and lower its overall

valuation.

SaaS firms often suffer from customer churn.

Churn rates of 1% to 5% are common,

sometimes they can escalate to whopping

15%-20%%. This can mean significant losses in

yearly revenue. While a 100% customer churn is

not practical or even desirable, top organizations

in service industries such as mobile operators or

internet service providers enjoy much lower churn

rates of 0.3% to 0.6%, which creates additional

opportunities to drive referrals, increased sales,

and lower CAC. SaaS companies operating at this

level of performance could increase profitability

per customer six fold.

This white paper outlines current challenges in

churn management, describes leading practices

for developing a knowledge of true churn causes

and priorities, and covers the organizational

challenges that must be overcome to eliminate

the root causes of churn and increase profitability

as a result. It is based on a collection of best

practices of top-performing service providers in

areas including planning, development,

marketing, sales, operations and customer care.

Adopting these practices will help you retain

more customers, boost revenue, and create a

sustainable competitive advantage.

Executive Summary

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There are certain advantages and disadvantages in

the general shift to subscription business model

that more software companies are currently

making. The advantages of this shift is that

revenues have become much more predictable

and stable. The software companies now have

more available data than ever before about their

customers. Moreover, adding and supporting

application features and functionality is much

easier to do in Cloud based products than in their

on-premise counterparts.

The disadvantages, on the other hand, are that

companies have to keep re-selling the sale in order

to retain these customers over time. The valuable

customer data is normally scattered all over the

company and is therefore not easily accessible.

Another challenge of subscription business is that

competition doesn’t stand still and is rapidly

adopting the same features to their applications

too.

The meaning is clear. In the SaaS/Cloud business

model, what is really being sold, is a relationship

rather than technological features and functions,

and keeping that relationship profitably going for

as long as possible is the core issue for long-term

success as a SaaS company.

Introduction

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The COST of Churn

In the start-up phase, it is very difficult for SaaS

companies to assess the real impact of churn as

they lack the longitudinal data. In their “land-

grab” phases, SaaS companies normally do not

have time and money to worry about attrition. It

makes sense for the first year or two after the

product was launched. Especially attrition is

overlooked when the service is offered to

customers on a yearly agreement basis; the

company enjoys growing profits and customer

base. However when the first contracts start to

expire, the churn starts to affect Monthly

Recurring Revenue (MRR) values.

Surprisingly, there is no standard calculation for

customer churn. Many companies use different

measurement windows, include or exclude

customers that join or leave during the period,

separate the data by type of churn (voluntary or

involuntary), use recurring revenue instead of

number of subscribers, or choose figures with

either the beginning, ending or average customer

count over the term. In order to keep this paper as

simple, we will therefore define:

This definition excludes any customers added

during the year. For example, a SaaS company has

1,000 customers on January 1, and of these, 200

cancelled their subscriptions by December 31,

making the annual churn 20% (20/1,000). The

average monthly churn is then approximately

1.7% (20%/12). Of course companies may favor

other calculations, for other purposes, but gross,

relative performance is sufficient for the analysis

performed for this white paper.

Churn is a cummulative problem. The income lost

during a year continues to be lost next year and

the year after.

Annual Churn Rate = No. of Customers who Left by Year EndNo. of Customers at Beginning of Year

As a SaaS company grows, absolute churn increases with the total number of existing customers and will limit growth if new customers are not added at a faster and faster rate.

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Source: Chaotic Flow

SaaS Capital, a provider of debt-based growth

capital for SaaS companies, provides an excellent

example:

Two SaaS companies sell only software

subscriptions; no other income sources are

included. Both sign 10 new subscriptions per

month at $1,000.00 each. Both spend $120,000

per month on sales and marketing to acquire

those relationships (CAC). The only difference

between them is that one has a customer

retention rate of 95%, and the other one only

80%. At the end of 5 years, the difference in

bottom-line company valuation between the two

was $15 million. Along the way, the company

with 95% retention rate also has increased

revenues to work with up to $24,000 per month.

From the above example it can be concluded that

company profitability is closely tied with

per-customer profitability when sales and

marketing costs are included: customer

profitability = CLV - CAC (Customer acquisition

costs). Naturally, if CLV is equal to or less than

CAC, the company has a problem. The Average

Lifetime of a Customer is equal to 1/Churn, so

cutting churn rate in half doubles CLV and

per-customer profitability. Acknowledging this

leads to a stunning conclusion: even small

reductions in churn can make a big difference.

To complete the picture, not all churn is bad.

Some customers buy a product only to see it

doesn’t fit their needs. Others consume a

disproportionate share of support resources, and

therefore, are too costly to serve. Some have

unrealistic demands, others are abusive or try to

damage a company’s reputation, consequently

consuming more marketing resources. Bottom

line is, a small percentage of attrition will always

be present.

Customer Lifetime Value (CLTV) formula:

CLTV = Average Lifetime of a CustomerX (MRR - Monthly Cost to Serve)

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CAUSES of Churn

A hidden trap many SaaS companies get caught

in is over reliance on churn predictive modelling.

Desperate to stop the churn wave and plunging

profits, the solution seems fairly obvious: by

leveraging the rich customer data scattered

throughout the organization, the companies

should be able to predict if the customer is most

likely to churn in the near term and then create

activities to prevent them from churning. It’s an

appealing option, the market is full of relatively

inexpensive solutions and experts that build solid

churn models in only weeks or months. Any

statistician can confirm that the model performs

as promised - predicting who is likely to abandon

the service.

Many companies have created Customer Success

Management functions assigned to enrich the

user experience. They deliver a positive customer

onboarding experience. Equipped with a special

toolkit full of loyalty programs they rush to the

most at-risk customers to save them from

churning.

These are good steps, but they are not enough. It

can be compared with a doctor who is treating

only those patients, who are about to die, but

without knowing which diseases to treat.

It is far more efficient to investigate why the

customers are leaving. Once the root cause

becomes known, targeting at-risk customers with

the right offers can be accomplished with

maximum efficiency.

1. A hidden trap

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Customer attrition observed in the SaaS business

can be associated with many factors. Service

Excellence Partners, a business consulting firm

specializing in SaaS companies, studied customer

loyalty in many different companies. They found

that customer churn is often associated with

failure of the supplier to deliver certain benefit

types:

IMPLICIT. The customer learns the service is

missing a basic feature or lacks performance

they normally take for granted. For example: an

internet service provider that drops connection or

a cleaning service that leaves dirt behind. When

obvious expectations go unmet, customers have

the greatest dissatisfaction and are most likely to

churn.

EXPLICIT. The customer realizes a specific

promise in the sales process regarding

features performance, or cost is not being kept.

For example: a bill for the service is much higher

than quoted, an internet service provider doesn’t

deliver the promised connection speed or the

coffee at the new cafe is not as good as they

were promised. The customer may never return if

the issue is severe and the dissatisfaction is high

enough. If a competitor promises comparable

benefits, and changing providers is painless and

cheap, potential for churn grows.

EXPERIENTAL. The customer discovers a

mediocre ongoing relationship with the

supplier. For example: a customer care

representative was unhelpful, a sales

representative who only reaches out when selling

something or a rude waiter. Even though the

service meets specifications, customers churn

when they feel ignored, devalued, or treated

unfairly by the company or its employees.

At this point the conclusion is fairly easy;

customer retention, requires involvement from

top management and often changes in the way

the company operates. All functions in

development, marketing, sales and service

contribute to customer experience, and

consequently renewals, up-sells, and loyalty.

The next chapter will describe the most efficient

methods in churn prevention.

2. Identifying the root causes

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Best PRACTICES in churn prevention

Going back to the idea that not all churn is bad;

it is important to prioritize targets according to

the most profitable customers during the initial

phase of the development of a churn prevention

strategy. To identify these customers, the top

management should ask themselves the

following questions:

To make that initial sale, a company needs to

know quite a lot about its prospect customer.

All of this knowledge and more make the

signature on the first contract possible. To get the

renewal signatures, however, a company will

have to keep this data up-to-date and to add to

it. A very good way to complete the available

data is by conducting on-boarding and exit

surveys. Account management and support

departments can prove very useful in supplying

the necessary data for each segment, as theses

departments are constantly in direct contact with

the customers and their challenges. Moreover,

recording calls and other interactions with the

customers can help identify quality issues of these

departments.

By scoring each segment accordingly, sales and

marketing teams can then use this data to direct

their outbound and inbound efforts based on

top-level strategic priorities.

1. Setting Priorities

Who are these customers?

How valuable is each segment?

What is the Monthly Cost to Serve

(MCS) for that customer?

What were their business needs and

requirements?

Who were the decision makers and

influencers?

What were the timetable and budget

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One of the major benefits of the SaaS and cloud

computing trend is the ease with which

companies can purchase, implement and

consume services, at individual price points far

less than their on-premise counterparts. This

‘consumerization of the enterprise’ also allows

the individuals to purchase enterprise SaaS

services for themselves, their work group or even

company as a whole, without going through a

centralized purchasing department.

The critical challenge of this aspect is ensuring

that people can pay online for the service with

automatic payments, especially in subscription or

recurring billing environments. These automatic

payment methods include credit and debit cards,

e-wallet services, ACH, PayPal. An immediate

direct benefit of accepting automated online

payments against relying exclusively on invoices is

radically reducing Days Sales Outstanding (DSO)

and significantly improving cash flow.

Regardless of the business model, measuring

usage and engagement is a great mechanism to

validate the pricing models.

Are the heaviest users underpaying or

overpaying relative to the infrequent

users?

Are the heaviest users provided with

cross-sell/up-sell opportunities more frequently

than the light users?

Is the support team enabled to engage in sales

activities based on customer interaction?

Pricing and packaging are not only the matters

that play an important part during the

onboarding phase, but also when the customer is

frequently using the service that counts. How the

company segments customers with respect to

upgrades and when the customers are pitched

are both important. For example, customers who

previously churned shouldn’t be pitched, the

offers should be pitched to customers who are

already beyond the Average Customer Lifetime

Value (ACLV).

2. Embrace the individual

3. Tailor pricing and packaging according to customer usage

4. Manage upgrade segmentation

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As a SaaS business is all about recurring

revenues, a SaaS company should focus its

business activities around crafting long-term

customer lives. However, most companies focus

their customer acquisition efforts around

conversion rate optimization, especially if they

offer free trial or a freemium offering. They then

rate their various marketing campaigns and

activities around that metric (for example:

product demos or webinars drove the highest

conversions, so they direct money into

developing additional webinars).

To reach to a more relevant KPI, it is necessary to

understand which marketing activity lead to the

longest customer lives. Once the marketing

teams segments the cohorts by customer life and

marketing campaign, they can then optimize for

those acquisition activities that drive the biggest

gains in overall revenue, not just conversion rates.

As many SaaS companies rely on an ecommerce

providers’ services to handle recurring payments

and billing, many SaaS businesses face significant

amount of churn every month, even though

these customers want to remain subscribers.

Often the reasons for this involuntary type of

churn can be errors in payment failure. A

subscriber’s card can fail for a number of reasons

- from failures in the card association network, to

the subscriber being temporarily over their credit

limit. How these involuntary churns are managed

can mean hundreds of thousands in additional

revenue to the SaaS business, and few businesses

understand the payment networks well enough

to optimize this retention aspect on an on-going

basis.

Because the payment provider plays an important

part during the onboarding and renewal phases,

it’s crucial to identify a platform that offers the

necessary amount of individual care and

attention to each of their company’s clients by

offering the tools that deliver flexibility, tailoring

subscriptions around product requirements

without system capability restrictions. Another

aspect to consider would be if the provider is

using cascading payment gateways to ensure

recurring payment success.

5. Align customer acquisition with long-term customer lives

6. Better subscription handling

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Conclusion

The conclusion is obvious; churn is risk and the

best way to deal with risk is by avoiding it

altogether. The churn prevention shouldn’t start

only when the effects of attrition start to show.

This prevention should be the user experience

delivered by the employees of the whole

company.

The benefit of the cloud computing is the wealth

of data that has never been available ever before.

By performing data-mining on an ongoing basis

and extracting valuable insights from it, SaaS

companies can identify and efficiently address the

potential causes of churn that can potentially

cripple the company. Since most churn reduction

initiatives require changes and support across

several functional areas, hard decisions will need

to be made. It is essential that a clear and

compelling set of facts get established that will

focus and drive successful churn management

initiatives.

Better results come from better strategies. By

leveraging the insights gained from data, the

company can implement better approaches to

reduce churn. By adapting at least some of the

practices described in this paper and making the

improvement habitual, SaaS firms can retain more

customers, generate more sales through referrals,

and dramatically improve profitability.

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About PayPro Global

PayPro Global provides flexible e-commerce solutions that enable software and SaaS companies of all sizes to build and grow their online businesses, reduce costs, minimize risks and enter new markets. The company’s offer includes flexible and automated recurring subscription billing, real-time business

reporting, 24/7 customer support, fully customizable checkout, assistance in web design, sales and marketing.

To have a deeper conversation on the topic, please contact us at:

marketing@payproglobal.compayproglobal.com

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